The Higher-Education Bubble and Third-Party Payer

Taxes and spending are two of the most obvious burdens imposed by government, and I’m glad that many people are fighting against a political class that seems to have a limitless appetite for a bigger public sector.

But politicians also can do great damage to an economy with mandates, regulations, and other forms of intervention. And because they are indirect and somewhat hidden, these costs are poorly understood by most voters even though the burdens can be enormous.

Interfering with the price system is an especially pernicious form of intervention.

When functioning properly, prices enable the wants and needs of consumers to be properly channeled to producers and suppliers in a way that promotes prosperity and efficiency.

Unfortunately, governments hinder this system with all sorts of misguided policies such as subsidies and price controls.

One of the worst manifestations of this type of intervention is the system of third-party payer, which occurs when government policies artificially reduce the perceived prices of goods and services.

In this post, let’s look at markets for higher education, housing, and health care to get a better understand of how third-party payer leads to rising prices and damaging bubbles.

Let’s start with the market for college education. Glenn Reynolds of Instapundit has been promoting the idea of a higher-education bubble for years. His theory, as he explained in the Washington Examiner, makes a lot of sense.

A couple of years back, I suggested in these pages that higher education was facing a bubble much like the housing bubble: An overpriced good, propped up by cheap government-subsidized credit, luring borrowers and lenders alike into a potentially disastrous mess. …This is a simple case of inflation: When you artificially pump up the supply of something (whether it’s currency or diplomas), the value drops. The reason why a bachelor’s degree on its own no longer conveys intelligence and capability is that the government decided that as many people as possible should have bachelor’s degrees. There’s something of a pattern here. The government decides to try to increase the middle class by subsidizing things that middle class people have: If middle class people go to college and own homes, then surely if more people go to college and own homes, we’ll have more middle class people. But homeownership and college aren’t causes of middle-class status, they’re markers for possessing the kinds of traits — self-discipline, the ability to defer gratification, etc. — that let you enter, and stay in, the middle class. Subsidizing the markers doesn’t produce the traits; if anything, it undermines them. One might as well try to promote basketball skills by distributing expensive sneakers.

I hope he’s right, and I also hope the bubble bursts quickly. The last of my threekids is a senior in high school, so anything that lowers tuition and fees would be most welcome.

But let’s look at some data and think about whether this will happen.

This first chart, using data from the Bureau of Labor Statistics on college tuition and fees, certainly shows a big jump in the cost of higher education. Indeed, tuition and fees have climbed more than twice as fast as the overall consumer price index.

Now let’s look at the Case-Schiller data on housing prices in the second chart. While the lines aren’t identical, it certainly seems like Instapundit is on to something. When the government intervenes in a sector of the economy with lots of subsidies, prices climb rapidly.

The key question, of course, is whether the market for higher education will behave the same way as the market for housing. In other words, has the government created a house of cards that inevitably will collapse?

As noted above, I hope there’s a bubble that’s on the verge of bursting. But since I tend to be a pessimist, I’m worried that the education market may be more similar to the healthcare market rather than the housing market. Take a look at this final chart, showing what seems to be endlessly rising prices for medical care.

So why do I worry that higher education may be more like healthcare? Because both benefit from third-party payer, which happens when someone other than the consumer pays a significant share of the cost of a product. For instance, consumers directly pay for only 12 cents of every dollar of healthcare they consume. So why care about rising prices when somebody else is picking up the tab?

Indeed, in the few areas where out-of-pocket expenditures dominate, such as cosmetic surgery and abortion, we find that prices are stable or even falling.

So what does all this mean? The honest answer is that I don’t know, but I fear that there is no looming collapse in the price of higher education. At best, we have probably reached a point where prices have leveled off, but that’s more a function of a glut in certain fields such as law.

30 Responses

As you point out, a large part of the burst of the housing bubble was the easy money and easy credit policies, policies which could have been avoided if only the banks had been allowed to make legitimate judgments about who was and who was not credit worthy.
I fear a similar thing is happening in higher ed. As more and more people decide they should go to college, we are lending money to people who may have little chance of succeeding in higher ed.
I’d be interested if there are statistics on college loan defaults of dropouts versus graduates, which might indicate that as the retention rate drops, the odds of a bubble would increase. But I’m not a statistician or even a social scientist, so I’ll have to rely on someone else to do that analysis.

In the process of devaluing the college education, by granting it almost automatically to people that have poor critical thinking skills, this is removing the college degree as a marker for deciding who to hire and who not to. Instead this is creating a secondary market, as creating hard driving people with good critical thinking skills are still very much in demand. The college degree is now necessary for employment but not sufficient. The actual decision re hiring now falls to consultants who can devise effective batteries of tests to weed out the folks who have been placed in colleges and who will add nothing to the skill set of the company.

STOP BLAMING FANNIE FREDDIE
THEY HAVE NEVER CREATED A MORTGAGE
THEY BUY MORTGAGES FROM BANKS AND SELL TO INVESTORS
THEY ARE A PRIVATE STOCK OWNED FOR PROFIT CORPORATION OVER SEEN BY GOVERNMENT

THE FRAUD WAS IN THE WRITING OF MORTGAGES

ONE HALF TOXIC MORTGAGES WERE WRITTEN BY PRIVATE LENDERS

F&F WERE LIMITED TO $153,000 IN 1988 ND INCREASED TO $300,000 MAX MORTGAGE IN 2002
UNTIL UNTIL UNTIL
BUSH INCREASED MAX TO $729,000 IN 2005. BANKS THEN UNLOADED TOXICS THEY COULD NOT SELL IN SECURITIES. TOTAL GIFT FROM BUSH TO BIG BANKS .

Yes, third party payer systems do inflate prices, however, there is still a huge difference between the higher education bubble and the healthcare bubble. In the healthcare bubble, there is real demand because of the rising elderly population and shrinking supply (fewer people going into medicine and more doctors refusing to participate in Medicare). That bubble won’t burst for another 20 years or more when the elderly population will begin to peak, and perhaps 30 when it starts to shrink.

This situation is entirely different for the college age group because birth rates have declined by 43% since 1960 caused by wider use of birth control and the fact of 55 million abortions — 30% of the entire generation under 45. Without these factors, that age group might have 100 million more people altogether — totally changing the supply-demand ratio for higher education. With a 43% decline in birth rate, colleges should be in crisis right now, but student loans — which many are unable to pay — have hyped demand. That crisis is coming with the collapse of the student loan market, which is almost inevitable. When it happens, it won’t be pretty.

The housing crisis is a very different story. It fell naturally with the mortgage crisis — too few people could carry the mortgages — and the crisis was heightened by mortgage speculation. But the major factor, again, was that 43% drop in birth rates. As Boomers began retiring, they had no one to sell their big, 4-bedroom and vacation homes to, so they had no quick exit from their inflated mortgages. Our entitlement government is still trying to intervene, but the problem is too big to for even them to handle.

Another crisis not mentioned is consumer credit, which may well collapse simultaneously with the student loan bubble. Both ends of the demographic curve are affected — 20, 30, and 40-year olds (many un-employed or under-employed) at one end and seniors still carrying huge loads of consumer credit into retirement. When that goes, we’ll have the third wave down on this current long term bull market top.

Just take a look at a 20-year chart of the DJI, and you’ll see it. Now forming is the top of the third wave in a major head and shoulders top. Even if you are not a technical analyst, it should strike you as one of the scariest tops in market history. If it breaks down, the DJI could fall by 50%. Current lower market volumes reinforce the case for such a market drop.

When it happens, hopefully, it will also be the end of big government intervention.

The Center for College Affordability seems to do good work on the topic including a great paper examining in detail why there is likely a tuition bubble being blown:

http://centerforcollegeaffordability.org/uploads/Bubble_Report_Final.pdf
“A Tuition Bubble?
Lessons from the Housing Bubble
l. If the suppliers do not expand production, the end result is an increase in price, with the suppliers capturing the entire subsidy and the consumer still paying the same amount (or more, if he is not lucky enough to get a subsidy). When it comes to higher education, there is reason to believe that an expansion of production is unlikely to occur. ”

They also go into other issues leading to rising prices in this paper examining “Financial Aid in Theory and Practice” where e.g. they talk about an unfortunate relationship between spending an the prestige of a school:

Dan, a couple of thoughts spring to mind. (1) healthcare’s payoff is living. Hard to argue that is not price elastic. A college degree–not so much (2) Medical bills can be resolved through bankruptcy. Student loans excepting disability of the borrower(s)–again, not so much.
I would expect to see educational alternatives move in to exploit the price differential and, perhaps, forward thinking college administrators will catch this wave.
There does not seem to be a healthcare alternative on the horizon. Rationing healthcare is not an equivalent measure but it is the most likely outcome of the rising costs.

The colleges know that the gov’t is a cash cow. They are and will continue to milk this as long as they are allowed at the teat. They will continue to ease academic standards both through the administration level, and by individual instructors, so as to maintain enrollment. Why, if the professors fail too many of the low-achieving students they’re now inundated with they might be out of a job! A BA is an easy, first-tier eliminator for most companies, much as a high school diploma used to be.

Hurricane Katrina put a big dent in the housing supply in 2005. There was already a strong demand for housing and construction workers. Florida was hit by about four (4) significant hurricanes (Charlie, Florence, Ivan, and Jeanne) a year earlier in 2004. Hurricane Katrina caused lots of damage. There were a total of 15 Hurricanes and 12 named Tropical Storms in 2005. There were other problems in Florida such as insurance. “Mark to Market” is a definite complicating factor.

My oldest daughter enrolled in college in August of 2000. I didn’t think tuition could continue to go up as it had previously. My 2nd (and last) child graduated in May of 2008.

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